Italy Pays for Long-Term Debt, but Key Auction Proves Smooth

Solid domestic demand helped Italy to auction three-year debt with lower borrowing costs Friday than at a previous similar auction last month, even despite the tough backdrop of a two-notch downgrade of Italian debt overnight.

The auction as a whole wasn’t entirely smooth; persistent volatility and poor sentiment meant that borrowing costs moved higher on three longer-dated non-benchmark bonds, which accounted for a smaller part of Friday’s overall €5.25 billion’ ($6.412 billion) worth of supply.

Moody’s Investors Service Inc. downgraded Italy’s rating by two notches to Baa2 overnight, citing a greater likelihood of a further sharp increase in funding costs or loss of market access given euro-area risks and a general economic downturn.

The Italian Treasury launched the new three-year bond series, BTP 4.50% July 2015, at a yield of 4.65%. This is below the 5.30% it paid to investors mid-June to sell a tranche of the 2.50% March 2015 BTP. At Friday’s auction, the Treasury sold the maximum targeted €3.5 billion of the July 2015 BTP. It received €6.063 billion in bids for this new line.

Funding costs were much higher, however, for the three longer-dated non-benchmark bonds. It sold the maximum targeted €1.75 billion in these three bonds.

The Treasury paid a yield of 5.58% on the BTP 4.25% September 2019, up from 4.30% previously on March 14. It paid a yield of 5.82% on the BTP 5% March 2022, up from 5.66% on May 14. And it paid a yield of 5.89% on the BTP 4.75% August 2023, up from 5.57% on April 12.

“Once again, the Treasury was able to get its debt out the door which, right now, is the overriding priority,” said Nicholas Spiro, managing director at Spiro Sovereign Strategy, adding that domestic banks continue to hold the fort at Italian actions. “The concession, however, is still hefty and reflects the increasing risks in Italy,” Mr. Spiro added.

Friday’s auction received mostly solid demand, primarily from domestic investors, but RBC Capital Markets analysts said the overnight downgrade, which makes Moody’s the most pessimistic among the large three rating agencies, bodes ill for future demand in BTPs in general.

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